Should I Opt for a 1031 Exchange with my Land Investments? | Tyler Answers

September 22, 2023   |   Resources
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As explained by Tyler Davis, there are many benefits, as well as pitfalls, to utilizing 1031 tax exchanges in today's real estate market.

Dear Tyler,

I have inherited a sizable piece of land in Florida and I've been exploring selling the land and doing 1031 exchanges as a possible avenue to enhance and diversify my current assets. Could you shed some light on how a 1031 exchange might benefit my investment portfolio? What tax savings are involved in 1031 exchanges?

- A Florida Landowner

Section 1031 allows a taxpayer to replace sold property with “like-kind” replacement property and defer the tax on the sale. While many of these land transactions involve farmland, timberland, or ranchland, it's essential to understand that this tax-deferral mechanism can benefit a broad range of Florida land investments, regardless of the specific property type.

Numerous clients have sold land (of all types) and reinvested the proceeds in income generating commercial property investments.

Let's explore how a Section 1031 tax exchange can be a game-changer for your Florida or Georgia investment portfolio.

What is a 1031 Exchange?

Under Section 1031 of the Internal Revenue Code, a 1031 tax exchange allows property owners to sell one property and reinvest the proceeds in a “like-kind” property without triggering immediate capital gains taxes. This means that you can defer paying taxes on the profits from the sale as long as you follow the stringent guidelines set by the IRS.

Section 1031 defines a “like-kind” property as a property that is similar in nature or character as the property that is intended to be sold. However, this can be a little bit more broad than it sounds.

If you sell a piece of land, you can more than likely reinvest the proceeds into commercial real estate and qualify -  and vise versa. This flexibility allows property owners to diversify their real estate holdings.

Potential Pitfalls

While the benefits of a 1031 tax exchange are significant, it's crucial to be aware of potential pitfalls and seek professional guidance to ensure a successful exchange:

  1. Tax Deferral, Not Tax Elimination: A common misconception is that a 1031 exchange offers a tax-free transaction. In reality, it's a tax deferral strategy.

    You'll defer paying capital gains taxes until you eventually sell the replacement property. If any party involved in the exchange gains access to cash proceeds before the exchange, the capital gains from the sale may become immediately taxable.

    However, many property owners will execute Section 1031 exchanges until they pass away, allowing their heirs receive a “step up” in basis to fair market value on the date of death. If the heirs then sell the property for fair market value, there is minimal, if any, gain. So, Section 1031 exchanges can eliminate taxes altogether in some instances.

  2. Exclusion of Personal Properties: The IRS excludes personal properties like primary residences or vacation homes from 1031 tax exchanges. To qualify for a 1031 exchange, all properties involved must be held and used for business or investment purposes.

  3. Related Parties and the Two-Year Rule: Special IRS rules apply to 1031 exchange transactions between related parties, which can include family members or entities with significant ownership ties.

    These transactions must adhere to a two-year holding period for the properties involved. Disposing of the properties before this period may result in immediate taxation of capital gains.

To wrap up, a Section 1031 tax exchange can be a valuable tool for optimizing your Florida land investments, providing tax advantages and flexibility across various property types.

Whether you're considering transitioning within the realm of Florida or Georgia land investments or diversifying your portfolio, consulting with experienced tax professionals who understand the intricacies of 1031 exchanges is essential. This guidance ensures that you make informed decisions, maximize your investment potential, and navigate the exchange process effectively within the framework of Florida's dynamic real estate market.

Disclaimer: This article is only intended for informational purposes. SVN | Saunders Ralston Dantzler does not guarantee the sufficiency of the content in or linked to from this article or that it complies with current law. The content within this article is not a substitute for legal advice or legal services. You should not rely on this information for any legal purpose without consulting a licensed lawyer.

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Tyler Davis
Tyler Davis brings a wealth of financial knowledge to our team at SVN | Saunders Ralston Dantzler. His history in tax planning and consulting services have supported some of the largest insurance companies across the nation. Tyler's experience in finance has supported him throughout his c...